Public debt dynamics: a stochastic approach applied to Spain

Public debt dynamics: a stochastic approach applied to Spain

Series: Occasional Papers. 2420.

Author: Mario Alloza, Jorge Martínez, Juan Rojas and Iacopo Varotto.

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Summary

This paper presents a methodology for analysing public debt sustainability that incorporates factors that enable uncertainty in the macro-financial environment to be quantified. The aim is to identify risks, not only under specific assumptions, but also considering a complete characterisation of potential developments in the real economy and in financing costs, based on the historical evidence available. To this end, stochastic shocks are included in the equations for a standard debt sustainability analysis (DSA) model, using recent evidence to gauge their scale and recurrence. When applied to Spain, the results suggest that uncertainty over the macro-financial environment and the growing pressure of the costs of ageing pose a challenge for the sustainability of our public finances. Specifically, in the absence of new fiscal consolidation measures, it is estimated that the probability of public debt in Spain being above 100% of GDP in 2040 is 80%. However, in a scenario characterised by a consolidation policy consistent with the new European economic governance framework, that probability would drop to 20%.

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